Reading 4/5: Ethics Cases －LOS a, (Part 1) conduct, reading

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CFA Institute Area 1-2: Ethical and Professional Standards
Session 2: Ethical and Professional Standards in Practice
Reading 4/5: Ethics Cases
LOS a, (Part 1): Evaluate professional conduct described in each reading.

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With respect to the arrangement that BIA has with Accommodate, based on the provided information:

A) a violation has occurred because BIA charges the same fee structure to all of its clients.

B) no violation has occurred as long as BIA informs CFA Institute that the firm receives research information from the brokerage firm.

C) a violation has occurred because a firm like BIA is not allowed to receive research information from outside sources.

D) no violation has occurred since BIA charges the fee structure to all of its clients.

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Answer and Explanation

Watson has violated the Soft Dollar Standard. For directing the trades through a given brokerage firm, BIA is getting research that only benefits about 10 percent of the clients. The remaining clients are paying the same fees, but they are not getting the same benefit. If BIA were to inform all of its clients of the arrangement, it might not be a violation, but the vignette says that information has not been disclosed.

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With respect to how Jackson allocated the shares in the IPO of the technology company, has Jackson acted in accordance with the Code and Standards?

A) No, Jackson has violated Standard VI(B) Priority of Transactions.

B) Yes, Jackson allocated the shares of the offering fairly on a pro rata basis to all client accounts.

C) No, Jackson has violated Standard III(C) Suitability.

D) Yes, Jackson has maintained the confidentiality of the new client accounts with the underwriter in allocating shares of the offering.

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Answer and Explanation

Jackson violated Standard III(C) Suitability by allocating shares of the public offering to the two new client accounts without establishing an investment objective or guidelines for the accounts. Standard III(C) requires a reasonable inquiry into the clients financial situation, investment experience, and investment objectives prior to taking any investment actions. Such information must also be updated regularly. The Standard also requires that the appropriateness and suitability of investment recommendations or actions be considered for each client, including 1) client needs and circumstances; 2) basic characteristics of the investment involved; and 3) basic characteristics of the total portfolio. Although the shares were allocated pro rata across all client portfolios, no investment action should have been initiated for the new clients without appropriate consultation regarding investment objectives and guidelines.

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Given Brunswicks current ownership in New Medical, the Code and Standards require Jackson to:

A) not initiate any investment action prior to the information being publicly disseminated.

B) trade the shares in client accounts before any accounts for himself, family or friends.

C) buy more shares for any client accounts that are underweight the position.

D) not take any investment action but communicate the information to other members of the proxy committee in preparation for consideration.

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Answer and Explanation

Under the Code and Standards, Jackson should not initiate any investment action on the information provided by Watson in order to prevent a violation of Standard II(A) Material Nonpublic Information. The information provided by Watson involved a proposed confidential tender offer for New Medicals outstanding shares and, therefore, was material, nonpublic information. Information is material if its disclosure would have an impact on the stock value or if a reasonable investor would want to know the information prior to making an investment decision. Material is nonpublic until it has been generally disseminated to the marketplace and investors have had an opportunity to react to the information. Since the information involved a tender offer, Watsons communication to Jackson was possibly a violation of federal securities laws. Neither Jackson, nor Watson should take any investment action regarding New Medical. Upon receipt of the information, Jackson should inform his compliance officer of the information, but otherwise keep the information confidential. However, not responding to unsolicited requests from clients to purchase New Medical is a possible violation because it appears that he is not acting in the best interest of the clients.

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Given Watsons actions, all of the following are most likely violations of the Code and Standards EXCEPT:

A) Standard II(A) Material Nonpublic Information.

B) Standard I (A) Knowledge of the Law.

C) Standard III(E) Preservation of Confidentiality.

D) Standard III(A) Loyalty, Prudence, and Care.

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Answer and Explanation

Standard III(E) Preservation of Confidentiality does not appear to have been violated by Watsons actions. She does not appear to communicate any confidential information provided by clients, prospects, or her employer concerning the scope of any client-member, prospect-member or employer-member relationship. Watsons actions, however, do appear to violate Standard I (A) Knowledge of the Law, Standard II(A) Material Nonpublic Information and Standard III(A) Loyalty, Prudence, and Care. The information provided by Watson involved a proposed tender offer for New Medicals outstanding shares and, therefore, was material, nonpublic information. Information is material if its disclosure would have an impact on the stock value or if a reasonable investor would want to know the information prior to making an investment decision. Material is nonpublic until it has been generally disseminated to the marketplace and investors have had an opportunity to react to the information. Since the information involved a tender offer, Watsons communication to Jackson was possibly a violation of federal securities laws. Neither Jackson, nor Watson should take any investment action regarding New Medical. New Medical shares should be added to Brunswicks restricted list to prevent a violation. The communication of the tender offer information by Watson to Jackson, is a probable violation of Standard III(A) Loyalty, Prudence, and Care, since she serves on the board of New Medical, and has a duty to the firm. Finally, Watsons misuse of material, nonpublic information would also violate Standard I (A) Knowledge of the Law by not complying with applicable laws, rules, and regulations.

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With respect to the complaint Mills filed against Jackson, and the subsequent investigation of Mills by CFA Institute, which of the following statements is least accurate?

A) Jackson did not violate the Code and Standards if he provides Mills trading information to CFA Institute.

B) Jackson may not use the CFA designation without filing a Personal Conduct Statement on an annual basis.

C) Jackson violated the Code and Standards by putting New Medical Developments on its restricted stock list.

D) Jackson violated the Code and Standards by not responding to Mills.

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Answer and Explanation

Rules concerning the confidentiality of client information do not apply to investigations of CFA Institute, which will keep any information it receives confidential. Jackson does not violate a Standard by placing a stock on a restricted list when the firm is in possession of material nonpublic information, and this is a recommended move. However, unsolicited requests from clients deserve a response. Jackson is putting his self-interest above his own by trying to protect himself by not responding to client inquiries concerning New Medical. Members and Candidates must renew their commitment to abide by the Code and Standards on an annual basis.

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Sally Watson works as an equity portfolio manager for Brunswick Investment Advisers (BIA). Wally Jackson, President and Chief Investment Officer of the firm, is a CFA charterholder who supervises Watson and other investment professionals within the firm. Watson is a candidate in the CFA Program, and she has recently passed the Level II exam. BIA's clients include trusts, foundations, endowments, corporations, and high net worth individuals, including accounts for family and friends of its employees. Jackson and Watson manage client portfolios with a growth strategy and concentrate on holdings in the healthcare, technology, and communications sectors. About 10 percent of BIA accounts are actively managed.

Because BIA uses Accommodate Broker Dealer for executing transactions, Accommodate provides research to BIA regarding holdings in accounts that are actively managed. The fees Accommodate charges BIA competitive, and BIA applies the same basic fee structure to all its clients. BIAs clients do not know about BIAs arrangement to get research information from Accommodate.

The clients do know that Accommodate routinely allocates shares in IPOs that it underwrites to BIA. Jackson is eagerly awaiting the IPO of a new technology company that he intends to allocate across all current portfolios, including the proprietary account and accounts of friends and family. Based upon his research, Jackson feels this IPO has good potential and has been working to get an unusually large number of shares of the IPO.

BIA has recently been awarded two new client accounts, totaling $100 million, which are in the process of completing transitions from other managers. Although an investment objective and guidelines have not been formalized for the accounts, Jackson allocates shares of the IPO across all client accounts on a pro rata basis, including an allocation for these new client accounts.

Watson serves on the board of directors for New Medical Developments, a biotech firm in which she maintains significant stock and options. BIA owns 4.5 percent of New Medicals stock on behalf of its clients. At a special meeting of New Medicals board, Watson learns that Remedy Inc. is preparing a confidential tender offer for all of New Medicals shares outstanding. After the meeting, Watson sends an electronic mail message to Jackson detailing the offer.

Jackson immediately places New Medical Developments on BIAs restricted list so representatives of BIA cannot recommend the stock. As rumors circulate in the investment community about the tender offer, some of Jacksons clients call and ask him to look into the possibility of purchasing stock in New Medical Developments. Jackson is fearful of his situation and puts off such requests. As a result, one client, Craig Mills, files a complaint with CFA Institute that Jackson is not responding to his requests. Knowing the precarious situation he is in, Jackson decides to wait until the tender offer has been announced to address Mills complaint.

CFA Institute becomes suspicious of Mills, because he seems to have a history of trading stocks for which material information soon becomes public. As part of an investigation into possible insider trading activities, CFA Institute asks Jackson to furnish CFA Institute with Mills trading history.

Watson must notify BIA of all the following EXCEPT:

A) her ownership of the stock in New Medical Developments.

B) her position on the board of New Medical Developments.

C) her plans for taking the next CFA exam.

D) any independent consulting work she performs for third parties.

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Answer and Explanation

Watson does not have to inform BIA about her plans to take a CFA exam. She should be careful, of course, not to misinform BIA of her plans, i.e., say she will when she knows she cannot. All of the other notifications are required. Standard VI(A) requires her to inform BIA about potential conflicts of interest. Standard IV(A) requires her to inform BIA about any consulting work she performs.

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While copying some of her research materials at work, Mary Jones comes across a few incomplete research notes written by one of her colleagues. As a result of reading the notes, and without further review, Jones immediately changes one of her stock recommendations from sell to buy. Which of the following CFA Institute Standards has Jones violated?

A) Standard I(B), Independence and Objectivity.

B) Standard V(A), Diligence and Reasonable Basis.

C) Standard III(A), Loyalty, Prudence, and Care.

D) Standard III(B), Fair Dealing.

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Answer and Explanation

Jones has violated Standard V(A) by failing to exercise diligence and thoroughness.

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Kimberly Olson has recently become a CFA charterholder, and has just started a new job at Securities Online as a junior analyst. After preparing her first research report, Olson decides to consult with one of the senior analysts who make minor corrections to improve the content of the report. Olson makes changes to the report according to the senior analyst. Upon presentation of the report, Olson finds that statements made by the senior analyst contained incorrect information. Which of the following statements is TRUE?

A) Olson did not need to check the additional comments.

B) Olson should have accepted the editing because it came from a senior employee.

C) If Olson attributes those comments to the senior analyst, she cannot be held responsible for incorrect information.

D) Olson should have checked the accuracy of the comments.

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Answer and Explanation

It is the responsibility of the analyst to confirm that information provided is accurate. The fact that the person editing the report is a senior analyst is irrelevant.

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Milton Baker, CFA, prepares a research report on the dynamics of a stock price. In his study, he uses a considerable number of information sources, both outside sources and his companys own research papers, prepared for both internal and public use. The report will first be distributed at the monthly department meeting and then later will be published on the companys Internet site. He thinks that he may have neglected to mention some of his sources in his reference list but decides that he needs to be concerned about full disclosure of his sources only for the public version of the report, so he will wait to revise his work until after the monthly meeting but before it is published on the internet site. Which Standards does Baker NOT comply with?

A) Standard I(C), Misrepresentation, I(B), Independence and Objectivity, and I(A), Knowledge of the Law.

B) Standard I(C), Misrepresentation, only.

C) Standard I(A), Knowledge of the Law, and I(B), Independence and Objectivity.

D) Standard I(C), Misrepresentation, and I(A), Knowledge of the Law.

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Answer and Explanation

Baker has some doubts but does not initiate any action presuming they only apply to the publicly disclosed report. The lack of action is a violation of Standard I(A), Knowledge of the Law. He also violates Standard I(C), Misrepresentation, by failing to properly disclose the sources of his information, where necessary.

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Pamela Gee is a portfolio manager. She is planning to establish her own money management firm. She has already informed her employer, Branford, Inc., about her plans. In her remaining time at Branford, she can:

A) solicit Branford colleagues but not Branford clients.

B) start the registration of her new company.

C) inform her current clients about her resignation and let them know how to reach her, in case any problems arise in the future.

D) prepare a list of information from Branford files that she can use for future reference in client solicitation.

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Answer and Explanation

The only action that will not breach Standard IV(A) Loyalty to Employer, is to start the registration of her new company.

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Marc Feldman, CFA, is manager of corporate investor relations for a high-tech startup, zippy.com, in Boise, Idaho. Feldman is well-known in the high tech community in Boise, and Dragon.com has asked if he will help them organize their investor relations function on a consulting basis. They offer him an all-expenses-paid two-week holiday for two on Australia's Gold Coast in payment. Regarding this offer as a CFA Institute member Feldman is:

A) allowed to accept the offer only with written approval from zippy and from Dragon.

B) allowed to accept the offer only with written approval from zippy.

C) not allowed to accept such an offer since it effectively places him in competition with his employer.

D) not allowed to accept such an offer since the compensation is non-cash and, therefore, is hard to quantify for the purpose of adhering to the Code and Standards.

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Answer and Explanation

Under Standard IV(A) Loyalty to Employer, and Standard V(B) Additional Compensation Arrangements, Feldman is allowed to accept the offer, but only with written permission from both zippy and Dragon.

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Adam Core, CFA, is a supervisor at a brokerage firm. Recently he discovered a complicated mechanism that brokers are using to obtain referrals of new clients in exchange for reduced commissions and other benefits to existing clients. The new clients are not aware of this practice. Core consults with compliance counsel and initiates an investigation. Which of the following actions violates CFA Institute Standards?

A) Core makes sure that everybody in the company has a copy of the CFA Institute Code and Standards and a copy of the internal compliance system. He starts organizing special seminars on compliance with CFA Institute requirements.

B) Core proceeds with the investigation, coordinating his search with the compliance officer, the supervisors from another departments, the legal advisors, and his manager.

C) Core's first goal is to identify all violators.

D) Core starts collecting information and records on the case, as well as interviewing all involved employees. He decides against immediate limitations on their work, to insure the work of the company will continue undisturbed.

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Answer and Explanation

Given the possibility of a violation, Core must impose limitations on the normal activities of the suspected employees until the investigation is complete, as explained in Standard IV(C), Responsibilities of Supervisor.